John Hood, president and portfolio manager, J.C. Hood Investment Counsel

FOCUS: Options and ETFs 

MARKET OUTLOOK:

One Bonfire of the Vanities-the bond traders; part two

Tom Wolfe's novel became a best seller as Tom Hanks portrayed a hapless bond trader caught in the morass of the U.S. judicial system, racism and his own moral wavering and infidelities. In the wake of the October stock market crash in October 1987, bond traders were kings, the self-described "masters of the universe" making millions per year; recall Michael Milken in the 1980s.

Bond yields had peaked at 20 per cent during a time when we 'boomers' were buying our first homes. We would have danced in the streets to get today’s 4-5 per cent mortgage rates. As rates declined over 30 years, existing bonds went up, accelerated in 2008 with quantitative easing which spilled more money into the market, rates dived and bond prices kept on rising; until this year. An excellent article in last Friday’s Globe and Mail described how many bond traders seldom sold a bond at a loss during their careers, but not this year. That ended this year with many bonds in freefall.

The Canada bond index was down 10 per cent in the first quarter, with many bond funds and ETFs quoting 2.5 per cent yields at the beginning of the year, which are now down 5-10 per cent on a total return basis. There was a reason why, having sold all bond ETFs two years ago, we stayed in cash; it’s better to earn nothing than lose 10 per cent or more. Now that rates have begun to rise sharply, we have been buying three-year Government of Canada bonds yielding around 3.2 per cent. If rates jump again we will be buying a second tranche or buying U.S. Treasuries.

Is this a recession?

No. As I drive around the GTA, I cannot recall seeing so many "Help Wanted" signs, or employers complaining about finding workers. As Howard Schneider reported, there has never been a recession without a loss of employment. Jobs are being added in the U.S. by hundreds of thousands per month... industrial production has also been rising, and so have earnings in many sectors.

 As Christine Poole described, the U.S. consumer is 60 per cent of GDP and demand is strong, particularly travel-related demand.

Brian Belski, the chief investment strategist at BMO, stated inflation could fall faster than many people anticipate and upcoming earnings could exceed expectations.

As one financial wag remarked; “If this is a recession we need more of them.”

A bear market; possibly

 As you know I often quote Brian Westbury, an economist at Chicago-based First Trust, as he has been remarkably accurate in taking a bullish view on U.S. markets and we have followed suit. But Westbury is demurring on his prediction of 5,250 on the S&P 500 for the end of 2022. In fact, he is predicting no new highs above 4,797 and only if the Federal Reserve can engineer a soft-landing for a recession.

The Fed is raising rates much faster than expected. The good news is unemployment is down to 3.6 per cent and manufacturing is above 3.8 per cent, both above pre-COVID numbers. The problem is raising rates is a very blunt instrument. There is no question that too loose monetary policy created this inflation but the Fed could not have accounted for the Russian invasion nor its impact on oil and gas prices on the overall economy.

However, the S&P 500 P/E ratios posted a 22 per cent market decline and are now much more attractive at a more normal 17/1. I had targeted around 3700 on the S&P 500 as a re-entry point and finally, it got there so I bought ZQQ Nasdaq. I am also targeting other sectors of the U.S. market including health care and in general the S&P 500 on a graduated basis. If the market declines 10 per cent I will, but seven per cent etc…CDN banks are also looking very attractive at these prices.

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TOP PICKS:

Three-Year Canadian Bonds

These are difficult for retail investors to buy as there is no 'bond exchange' but an advisor should be able to buy them for you. I like that they are AAA bonds, with no risk and a short maturity. Held in client and personal accounts.

U.S. Treasuries

Around 2.9 per cent in USD accounts and also to get exposure in CAD accounts to USD. Not held by clients nor personally as yet.

iShares U.S. Aerospace & Defense ETF (ITA BATS)

PAST PICKS: February 22, 2022

Vanguard FTSE Canada All Cap Index ETF (VCN TSX)

• Then: $42.37
• Now: $38.37
• Return: -8%
• Total Return: -6%

Vanguard S&P 500 Index ETF (VSP TSX)

• Then: $71.98
• Now: $65.05
• Return: -9%
• Total Return: -9%

BMO Canadian Bank Income Index ETF (ZBI TSX)

• Then: $29.77
• Now: $28.20
• Return: -5%
• Total Return: -4%

Total Return Average: -6%